a question for the economic smart people

Okay, so I’ve been keeping up on the coverage of the economic disaster we’ve been having by reading The Consumerist and listening to This American Life, and trying to catch up on NPR’s Planet Money. And I’ve got a question, but I’m not sure where to ask it.

The problem as I see it is that we have a bunch of banks that are exposed to unknown risk by having sold credit default swaps and mortgage-backed securities. Nobody is able to say how much each bank or other organization is worth because while you have the list of assets that do have a value on them (standard stocks, buildings, equipment, whatever), you then have these other lists of assets that nobody can assign a value to because:

for the credit default swaps, nobody knows who’s going to go under next so nobody knows if a credit-default swap that was sold for $10 million might require a payout tomorrow of $1 billion or more, and

for the mortgage-backed securities, nobody really knows which mortgages are low-risk and which aren’t.

The way I see to resolve these items, while probably not easy or attractive for anyone involved, is for each bank and investment firm to drop their drawers and expose everything. Every credit-default-swap exposure, every investment, every mortgage they offered, every little piece of land and equipment they own needs to get published. Giant text file, giant spreadsheet, whatever. This will expose trade secrets and probably other things that each organization would probably rather remain unscrutinized, but at this point it’s either do this or the organization may not survive to exploit those trade secrets.

I can’t find the reference now [update: here’s one, about the Reconstruction Finance Corporation], but I seem to remember reading that in the 1930s after the bank runs of the late 20s, the US government set up a commission to do a full audit of every bank, where every bank was laid bare to this commission and either certified solvent or not. That sounds like a good start.

If not done by the government, then maybe it can be coordinated by the Treasury and someone can set up a huge Amazon Mechanical Turk job or something. Imagine that — “Save the economy! Read two pages of this bank’s financial statement, add up the numbers, get paid ten cents, and help certify these banks!” The best reference I can find is from the New York Observer, in 2002, after the Enron scandal, calling for a Board of Audit. Yeah, it goes against the grain of every self-respecting capitalist who worships at the altars of Reagan and Thatcher, but I ask you, where is your god now? Oh right, he’s prolonging the crisis by randomly dumping wheelbarrows of money at your doorstep.

At the very least, someone needs to be going through all the mortgages that make up these mortage-backed securities and doing the due-diligence that should have been done in the first place. Pull all the paperwork, call everyone up and ask for paystubs and tax returns, run the credit checks, and assign each mortgage a real risk value. Then, at least, you’ll know how many loans were worthless, and how many were real loans to people with the means to pay them back.

So if these are the ways out of the mess, why isn’t anyone doing it? Maybe things aren’t quite bad enough; but if you have roaches or flour moths in the pantry, the only way to get rid of them is by pulling everything out, cleaning the pantry, closely examining everything you’ve got, putting the bad items out with the trash, and putting the clean items back in the pantry. Only then will you get rid of the pests, and there’s no other way to do it.

I realize it’s not my industry and I don’t have any real connection to the financial world other than hoping I (along with everyone else) don’t get screwed by what goes on with it, but it seems like most folks are just sitting with their heads in their hands and hoping that the badness will somehow blow over and get better. I don’t think that’s the answer, and while right now it seems like this might help, I’d love to know how I’m wrong.